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Plugged In

When Hardware Sales Go Soft

By

Mark Veverka

April 21, 2003 12:01 a.m. ET

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IT'S FUNNY HOW TWO RESPECTED ANALYSTS can view the same facts so differently. Last week, both
Lexmark International
and
Hewlett-Packard
saw their stocks downgraded. Steve Milunovich of Merrill Lynch lowered his rating of H-P to the equivalent of a Hold, and Toni Sacconaghi of Sanford Bernstein downgraded his long-term recommendation for Lexmark to Hold. Meantime, Milunovich maintains a Buy on Lexmark while Sacconaghi rates H-P a long-term Buy.

So what gives? We highly value both analysts' opinions, having devoted a fair amount of real estate to their respective work.

Of course, while both companies fiercely compete in computer printers (H-P's strongest operating unit), that is where the comparison ends. H-P is really much more pre-occupied with
IBM
and
Dell,
and well they should be, says Merrill's Milunovich. "H-P is increasingly in the gun-sights of Dell and IBM, and that is a tough place to be," notes Milunovich.

Particularly troublesome is that H-P is the targeted prey of both Dell and IBM, Milunovich says. IBM is attacking the service-driven high end, and Dell is pounding away from the commoditized low end. He still thinks the marriage with Compaq gave H-P a better chance to compete than without it, but he is currently worried that H-P is losing ground to IBM in enterprise hardware. What's more, IBM reported last week that its hardware sales were soft, which does not bode well for H-P, assuming its hardware sales fared even worse. Milunovich expects H-P to rack up sales of $17.5 billion and earnings of 27 cents a share for its April quarter. But he is "nervous" about H-P not making its top line.

On top of that, "there is little question that H-P is Dell's primary target in personal computers, servers and now printers," he says. Both companies have cut costs in PC production, but Dell's savings have been used to slash computer prices and gain share, while most of H-P's savings must bolster the bottom line. "Competing against Dell strikes us as fairly hopeless in PCs," says Milunovich.

As for printers, which is H-P's crown jewel, the Palo Alto company has an "awesome franchise," Milunovich says. That's the good news. The bad news is he does not think H-P's printer and ink business can get any better. Thus, H-P could be a value trap. H-P looks cheap by almost any statistical measure, Milunovich concedes. The shares are trading only 13 times forward-looking earnings, and it boasts a break-up value of more than 20 a share, well above Thursday's close of 15.30.

There is little downside risk at this price, Milunovich admits. But the trouble is, there is also little reason for the shares to rise, with so much pressure being applied by competitors and the consumer market so vulnerable. "The stock is cheap, which is something I've been saying for a long time, but there are just a lot of things bothering me about it right now," he says.

For his part, Bernstein's Sacconaghi likes H-P precisely because it so darn cheap. Plus, he thinks there is still another $700 million to $1 billion in merger-related cost savings left to go. "It is interesting to note that the stock climbed from 12 to 21 at the end of last year, when H-P posted solid results in November, and I believe a similar sentiment swing [after next month's quarterly results] could lead to outperformance over the next several months," Sacconaghi told Barron's.

The irony is that Sacconaghi largely opposed H-P's buyout of Compaq, while Milunovich supported the deal prior to its approval. Now, nearly a year after the merger, they hold opposite views of the stock.

As for his downgrade of Lexmark, Sacconaghi simply feels that the stock is priced about right, with little inertia to climb higher. A staunch bull on the shares back in October 2000 -- he reaped a 147% return on his call -- the analyst now says that the printermaker has "grown into a premium multiple." Lexmark is slated to report first-quarter earnings on Monday.

The analyst points out that its forward-looking P/E has swelled from 12.9 in 2001 to more than 21. "Our downgrade is principally based on valuation. The stock is still secularly attractive, with strong margins and above-average stability, but investor expectations currently for the stock are high -- and perhaps too high, given that consumer spending is sluggish," Sacconaghi explains.

Valuation is in the eye of the beholder. "What's wrong with a 21-plus P/E?" asks Milunovich. A basket of big-tech names, consisting of
Microsoft,Cisco,Intel
and
Oracle,
carries a forward-looking multiple of 25.9, he says. In addition, the big-tech basket's average price-to-sales ratio is a hefty 6.1, compared with Lexmark's trimmer 2.0.

"For people who have to invest in tech, I think they should be buying Lexmark," Milunovich says, adding: "I guess Toni and I go in two different ways here."

Second Chance

Got Internet? Not all surviving Internet stocks are outrageously pricey, including
E-Loan
-- the re-tooled online provider of loans. The Dublin, Calif.-based micro-cap's shares have tripled from their July 11 low of 95 cents to their current $3.13.

Its fans include Palo Alto Investors, a California micro-cap hedge fund, which holds a 6.7% stake. PAO bought its first slug of shares in November 2001 at an average price of about 1.34. E-Loan, which is expected to announce earnings this Thursday, is trading above 12 times First Call consensus 2003 earnings of .25 a share.

"We still think that we are looking at an inexpensive stock and will continue to hold," says Ted Janus, a partner in the fund.

The knock on E-Loan is that it might be a one-hit wonder dependent on the home-loan refinancing boom, but that is a misperception, Janus says. While it has benefited from low rates and the re-fi craze, E-Loan originates loans. It is not just an intermediary, such as
Lending Tree,
which receives fees for hooking borrowers up with new lenders. Instead, E-Loan has been totally revamped to become an online originator of home mortgages, home-equity loans and auto loans. Even if refinancings cool off, Janus contends that the efficient low-cost loan provider's diversification into auto and home equity will allow it to weather any potential storm.

Says Janus: "We think this was the baby thrown out with the Internet bathwater."

Freedom Fried

Tech giants, especially software developers, like to hold lavish marketing conferences in warm and sunny climes to tout their wares and schmooze their customers. It is a part of the business, and accordingly,
PeopleSoft
-- the Pleasanton, Calif.-based enterprise software maker -- is slated to hold a swanky customer confab in Las Vegas.

For its part, PeopleSoft is billing its marketing meeting as a "leadership summit." And in keeping with the seriousness of the times, it has invited Her Majesty Queen Noor of Jordan to be the guest speaker. The American-born and Princeton-educated royal, who recently published her best-selling memoirs, certainly could provide fascinating perspective on the future of the Middle East in the wake of the war in her own backyard.

One humorously ironic note in all this is the planned location for the speeches: At the Paris Hotel, complete with faux Eiffel Tower. Pity the poor conference planners at PeopleSoft; there was no way they could have foreseen the icy Franco-American rift over Gulf War II.

In keeping with thematic symmetry, the nearby Aladdin Hotel might have been more apropos. Or in deference to Sept. 11, perhaps New York, New York would have made a better fit.

Instead, PeopleSoft finds itself holding its wartime soir&eacute;e in a hotel unpatriotically stockpiled with Bordeaux, Brie and Burgundy. Despite the overwhelming weirdness of it all, perhaps a little software will still get sold.

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